Economist, Telegraph Columnist, Broadcaster

The Republicans have a point, even if their tactics are wrong

Financial markets remain fixated on the question of whether or not America’s political classes will impose an entirely avoidable disaster on themselves, their fellow US citizens and, by extension, the rest of the world. While there are signs of rapprochement this weekend, Congress may yet fail to agree a new “debt-ceiling” limit. That could spark a world-wide market meltdown, so upending the fragile global recovery.

Those on the Democrat side of the aisle feel they’re on solid ground. The party controls both the White House and the Senate. President Obama’s sweeping healthcare reforms have been extensively debated, passed into law and ratified. And last year he was re-elected, no less, having campaigned on a ticket featuring this policy.

Yet the Republicans insist they won’t raise America’s debt-limit, an outcome that would result in a technical default of US Treasuries, the world’s most widely-held bench-mark asset, unless “Obamacare” is “de-funded” or at the very least delayed. The GOP is effectively ordering the US President, in policy terms, to slay his first-born, just as the carefully nurtured child is about to reach adulthood and make it way in the world. Unless the President complies, the Republicans say, America will be left to default on the asset class used to collateralize banks and derivatives markets across the world. Global markets would plunge, doing more economic damage than any single incident since the Lehman collapse back in the autumn of 2008.

By messing with the Treasury market, the Republicans have adopted an extremely harsh bargaining position, to say the least, one that holds not just their Democrat adversaries, but the entire world to ransom. Yet many in the party feel they’re entitled to make a stand and, anyway, have no choice.

The Democrats regained the White House, yes, but the result was far from “decisive”, many Republicans argue. While Obama prevailed in most of the swing states, winning convincingly in the electoral college which determines the Presidency, such states were won on wafer-thin margins, so the popular vote was extremely close.

The Republicans also hold a commanding majority in the House of Representatives, the other part of America’s bi-cameral Congress. And that majority, too, was won after months of campaigning, with the party arguing that deep spending cuts, rather than tax rises, are what’s needed to get America’s public finances under control.

Back in 2007, the annual US budget deficit was $169bn. By 2012, it had ballooned to no less than $1,100bn. This year, it will be smaller, as so-called “sequestration”, the result of previous Congressional budget skirmishes, checks spending growth. But the US will still be shouldering a deficit equal to around 5pc of GDP. And years of fiscal shortfalls have propelled the country’s national debt from around $9,000bn when Obama took office in early 2008, right up to the $16,700bn debt limit today. “Duty bound” is a phrase many Republicans use to describe their motives, as do their Tea-party comrades. How pleasing for them, then, that duty happens to coincide with causing the maximum discomfort for their political opponents.

You know what, though, the Republicans still have a point. America’s national debt is now 102pc of gross national income, and rising. The last time it was this high was in the aftermath of the Second World War, when the US was in its zenith, about to embark on a population boom and a run of rampant growth. America today, in contrast, is an ageing society, weighed down with liabilities stretching years into the future.

Above and beyond the fiscal warfare on Capitol Hill, there is no sign whatsoever of any political agreement on how to reform old age benefits so as to prevent the derailment of Uncle Sam’s finances over the coming decades as tens of millions of baby boomers retire. That’s why the Republicans are right to at least attempt to rein-in America’s ballooning entitlement spending before it spirals completely out of control. It’s hard to agree with their methods, but anyone who can add up, and is prepared to face fiscal reality, can see where they’re coming from.

After almost two weeks of hardline political rhetoric, the rest of the world is furious at America’s political elite. The last “debt-ceiling” crisis was back in the summer of 2011 and, even though default was avoided, the dysfunctional nature of the negotiations meant the US lost its triple-AAA credit rating with S&P. If we see a downgrade from either or Fitch or Moody’s, the other two main agencies, then major market volatility will ensue. Plus, we’d then be just “one more downgrade away” from an unequivocal removal of US T-bills’ “safe” status – an outcome that could cause a financial earthquake, as thousands of fund-managers were legally-required to make major asset re-allocations.

China and Japan, America’s two major creditors, have responded to this crisis so far through pursed lips. “Safeguarding the debt is of vital importance to the economy of the US and the world,” said Zhu Guangyao, China’s Vice-Minister of Finance. We can assume his words were cleared by Li Keqiang, the Chinese Premier. The Peoples’ Republic, after all, has around two-thirds of its $3,500bn of reserves in US assets, including Treasuries. The dollar collapse that would follow a default would seriously denude the wealth of the world’s second-largest economy.

Toward the end of last week, there were signs that the Republicans, having made their point, were starting to soften. The party seems to have lost the media battle, with polls suggesting that around half of Americans blame the GOP for the crisis, while the Democrats attract the ire of around a third.

There is no reason why the US should default, of course. Debt service amounts to around 7pc of state revenues, so there should be no problem. Yet Treasury Secretary Jack Lew has warned that lumpy government receipts and seasonal spending commitments mean the US is due to “run out of cash” on 17th October, with no guarantee that international investors would take precedence over social security payments.

After “adult conversations”, it now looks as if a deal might be done, with the Republicans offering to extend “extraordinary measures” so the deadline can stretch to November 22nd. In return, the GOP wants Obama to commit to deep spending cuts and may yet insist he accepts the non-implementation of his 2010 healthcare law. During this six-week grace period, too, Republicans may insist on the continuation of the current “government shut-down” – which has already led to the closure of numerous government buildings and services, as public sector staff are forced to stay at home.

There will be more political pyrotechnics before this latest debt-ceiling row is resolved. And all that means that the “tapering” of quantitative easing will be kicked further down the road. Can you imagine the state of global investor sentiment if, in the middle of America’s current policy chaos, the markets were also trying to cope with the US attempting to wean itself off its $85m-a-month money-printing habit?

For now, the mood remains relatively sanguine. Last week’s nomination of “ultra-dove” Janet Yellen as new Federal Reserve Chairman, replacing Ben Bernanke, has allowed markets to convince themselves that perhaps “tapering” has been delayed, with some talking about QE continuing at the current pace “until 2016”.

While investors have granted the US political classes more time, few believe that America’s longer-term fiscal problems or debt sustainability will be tackled. It pains me to see a great country like America, an icon of freedom and democracy, managed in such a cack-handed fashion. There must be a better way.